## Learning Outcomes

After reading this article, you will know how to identify and explain the key factors an external auditor considers when evaluating an internal audit function and its work for the purpose of a financial statement audit. You will be able to recognise the significance of objectivity, competence, and a systematic and disciplined approach, and apply these concepts to ACCA-style scenarios.

## ACCA Foundations in Audit (FAU) Syllabus

For ACCA Foundations in Audit (FAU), you are required to understand the factors that influence the external auditor's decision to rely on work performed by internal auditors. Focus your revision on:

- The distinction between internal and external auditors
- The factors to consider when assessing the internal audit function (objectivity, competence, systematic approach)
- The assessment of specific internal audit work for audit reliance
- The procedures the external auditor undertakes to evaluate internal audit documentation and conclusions
- The effect of the evaluation on external audit planning and procedures

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. Which of the following is NOT a factor the external auditor considers when evaluating the internal audit function?
   a) Objectivity
   b) Competence
   c) Company profitability
   d) Systematic and disciplined approach

2. True or false? The external auditor may rely entirely on internal audit work if the internal audit team is competent and objective, and no further testing is required.

3. State two steps the external auditor performs when assessing if they can use specific work done by internal audit staff.

4. Give an example of evidence an external auditor might look for when reviewing the internal audit department’s approach.

## Introduction

Many organisations operate an internal audit function to monitor internal controls and provide assurance to management. However, the external auditor remains responsible for expressing an opinion on the financial statements. When the external auditor considers using the work of internal audit, they must first evaluate the quality and reliability of the internal audit function and its work.

The ability to assess these factors is frequently examined in the ACCA FAU exam. Understanding the key criteria—objectivity, competence, and the systematic and disciplined application of procedures—is essential to answering both written and scenario-based questions.

> **Key Term: internal audit function**
> An internal team (or external provider) responsible for assessing, monitoring, and making recommendations about the effectiveness of a company's risk management, control, and governance processes.

### EVALUATING THE INTERNAL AUDIT FUNCTION

External auditors may place reliance on the work performed by internal auditors, but only after evaluating the internal audit function as a whole and reviewing specific work assignments.

### Core Criteria for Evaluation

The external auditor focuses on three principal criteria:

- **Objectivity:** Assess whether internal auditors are independent from activities they audit and report at a high enough level to maintain unbiased judgement.

- **Competence:** Consider if internal audit staff possess suitable professional knowledge and experience, including ongoing training and, where possible, membership of recognised professional bodies.

- **Systematic and disciplined approach:** Evaluate whether the internal audit team uses structured planning, proper documentation, supervision, and quality control procedures in their work.

> **Key Term: objectivity**
> Freedom from conflicts of interest, allowing internal auditors to make impartial assessments and professional judgements.
> **Key Term: competence**
> The possession of appropriate technical knowledge, skill, and experience necessary to perform assigned audit work reliably.
> **Key Term: systematic and disciplined approach**
> The consistent application of structured audit procedures, including planning, supervision, review, and documentation.

### Additional Factors

Other considerations include:

- The status of internal audit in the entity: Is the function supported by management, and does it have sufficient authority?
- Are any restrictions placed on the scope of work or access to records?
- Does internal audit regularly communicate significant findings to those charged with governance?
- Are previous internal audit recommendations acted upon by management?

### Worked Example 1.1

**Scenario:** The external auditors for Parker Ltd are considering placing reliance on the company’s new internal audit department for testing payroll controls. Internal audit reports to the finance director, uses standardised working papers, and has staff with accountancy qualifications.

**Question:** What specific factors should the external auditor review before relying on the payroll testing work?

> **Answer:**
>
> - The auditor should check if internal auditors report to a sufficiently senior level and that their objectivity is not compromised by their reporting line.
> - They should confirm staff have appropriate accountancy qualifications (competence) and adequate training.
> - Review if the assignment was properly planned, supervised, and documented (systematic approach).
> - Determine that there were no restrictions on internal audit’s work for payroll and that findings are communicated to the board.

### EVALUATING SPECIFIC INTERNAL AUDIT WORK

Once the overall function has been assessed as reliable, the external auditor reviews the adequacy of specific internal audit assignments they intend to use.

![External auditor's decision process for assessing internal audit function reliability and the adequacy of specific internal audit work.](https://static.pastpaperhero.com/images/acca-fau-internal-audit-factors-for-evaluating-internal-audit-work_00.png)

_External auditor reliance is determined by reviewing internal audit quality and work adequacy, with ultimate responsibility retained by the external auditor._

Key steps include:

- Evaluate if the particular work was properly planned, performed, supervised, reviewed and documented.
- Check whether there is enough reliable evidence to support internal audit's findings and if these conclusions are appropriate.

If in doubt about any aspect, external auditors should perform additional tests themselves.

### Worked Example 1.2

**Scenario:** Internal audit performed controls testing on purchase invoices. The external auditor wishes to rely on this work.

**Question:** What approach should the external auditor take before deciding to use the results for their audit?

> **Answer:**
>
> - Inspect a sample of internal audit’s working papers for evidence of detailed planning, sampling, thorough testing, and sign-offs showing review.
> - Re-perform selected tests or observe procedures to ensure quality and integrity of the work.
> - Assess whether the tested population and period cover the period relevant to the external audit.
>
> **Exam Warning:**
> Reliance on internal audit does not remove the responsibility of the external auditor for the external audit opinion. Only after a thorough evaluation of both the function and the specific work can reliance be placed, and never on areas involving significant auditor judgement (e.g., key estimates).
>
> **Revision Tip:**
> When answering ACCA questions on this topic, clearly distinguish between evaluating the internal audit function _as a whole_ (objectivity, competence, system) and assessing _individual assignments_ (planning, evidence, conclusions).

## Summary

Before relying on internal audit work, the external auditor must assess the overall quality of the internal audit function focusing on objectivity, competence, and systematic application of procedures. Additionally, they must judge the adequacy of specific assignments by internal audit and are required to test and review selected work before using it for external audit purposes.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- The meaning and importance of evaluating internal audit for external audit reliance
- Factors considered: objectivity, competence, and systematic approach
- Additional considerations: status, authority, support, and independence within the entity
- Procedures for evaluating specific internal audit assignments, including planning, supervision and evidence review
- The limits of reliance and need for external auditor judgement

## Key Terms and Concepts

- internal audit function
- objectivity
- competence
- systematic and disciplined approach


Internal audit - Factors for evaluating internal audit work